Monday, July 25, 2016

Self-Insure For Routine Expenses Whenever Possible

People really don’t like paying their bills out-of-pocket.
This observation was brought home to me recently through several examples. I
had suggested that somebody drop their physical damage coverages on a 5+ year
old car. Someone who overheard objected that a cracked windshield (covered
under the Comprehensive coverage) could cost perhaps a few hundred dollars to
replace. I thought, “Yeah, a couple years’ premium for something that you’ll do
maybe once or twice in your lifetime.” In another case, I was being shuttled
back-and-forth between the garage and work while my car was being worked on. My
co-passenger was complaining that the extended warranty he’d purchased on his
car didn’t cover any of his repair costs that day. (In this case I was thinking,
“Who buys the extended warranties? Doesn’t everybody know these are overpriced ‘insurance’
policies?”) In another case, someone was trying to ensure that a series of
medical costs all fell in the same year, so that they would count toward her
deductible. If they were billed the following year, her deductible would
“refresh” and she’d have to pay those costs out of pocket. In another case, a parent
with several children was arguing with a dentist who didn’t deal with
insurance; the parent insisted that the dentist bill the insurer, rather than
the parent having to deal with the hassle of claims-handling himself. This
parent was a doctor, and I was thinking at the time, “Wow, even at the highest
levels of education, people don’t get it.” Finally, policy fights frequently
flare up in the news cycle over which trivial expenses should or should not be
covered by health insurance.

So far this is a pretty banal observation. “Duh. People like
to get free stuff more than they like to pay for stuff.” The problem is that
getting something paid for by insurance isn’t at all like getting “free stuff.”
When your insurer suddenly has to cover a cost that used to be paid by the
customer, it has to increase the premium charged to its customers to cover that
cost. In a sense the customer still pays, it’s just that they pay ahead of time
and the insurance company later gives them their money back. It’s actually a
little worse than this. The insurance customer *also* has to pay for the costs
of having someone handle his money for him: bank transaction costs, actuaries
setting cash reserves and pricing policy provisions, claims handlers who
negotiate with the hospitals, etc. As a one-off, it might feel like a quick win
to get your insurance to pay a bill that you were going to have to eat, but in
the long run it’s a losing game to make your insurer pay your bills for you. It’s
cheaper in the long run to self-insure for the small stuff.

You should never buy the extended warranty. These are always
priced to make a big profit, and suppliers generally make big margins on these
contracts. They may “pay off big” on rare occasions, but those are so uncommon
that you’re better off saving up for those rare mechanical failures. If you own
your car, you should either get a high ($1,000 or more) deductible on your
Collision and Comprehensive coverages or do away with them entirely. Yes, you
are exposing yourself to a larger share of repair costs if you get into an
accident, but the savings are substantial. If you have the discipline to save
aside those saved premium dollars rather than spend every penny you come
across, you can easily self-insure for that once- or twice-in-a-lifetime collision
requiring a lot of body work. I am *not* talking about liability coverages,
which cover expenses to third parties when you are liable for the accident. You
should always have a policy with high limits on liability coverages. I’m also not talking about uninsured motorist
coverage, which covers your medical bills if an uninsured (or inadequately
insured) driver hits you. Don’t skimp on that, either. Buy lots of coverage,
250k/500k if you can afford it. If you have a lot of assets, buy an umbrella
policy on top of your auto policy. When I say “self-insure”, I am only talking
about the stuff that won’t wipe you out, as a massive at-fault auto accident
might.

The general principle here is that you should self-insure as
much as is feasible. Insurance is about protecting assets. It’s not about
paying your expected, routine bills. That’s what a budget is for. There really
are those big hits that can wipe out your savings: a house fire, an auto
accident in which you seriously injure someone, a gigantic medical bill for
tens of thousands of dollars. Those are events that you should be insured
against. Insurance is for these low-frequency high-severity events, which are
so rare they might never happen to you in your lifetime and so expensive they
wipe out most or all of your net worth. But you shouldn’t be dipping into an
insurance policy for every piece of routine auto maintenance, and you shouldn’t
require a lifetime warranty to cover an appliance failure, which you should
expect to happen every few years or so. If you have the self-discipline to
actually save back the money you waste on these insurance policies, you will
save money in the long run by self-insuring.

Even for those expenses that are large but *expected*, you
should consider the possibility of self-insuring if it’s not too painful. Say, “I
know I’ll have to pay this expense three times in my life, so I’m going to save
up for it.” Think replacing a roof after hail damage (you should be replacing your
roof every decade or two anyway) or replacing a car after a minor accident (once
again, you should expect to replace a car a few times in your life). If you’re
in a position where your cash savings can cover these kinds of expenses, you
should consider getting a really high deductible on your home and auto policy
(or do away with comprehensive and collision coverages on auto altogether if
your car is old enough).

There are caveats to this. Of course if you are incapable of
saving money, you should pick the low deductibles because a sudden unplanned
for expense really will wipe out your savings. But this is a self-control issue
that I think people can voluntarily avoid if they wished to. Most people, if
they *really* thought about it and really showed some self-discipline, could
curtail their household spending and save more, perhaps even earn more. Once a
cushion of a few thousand dollars is built up, you can start doing away with those
expensive insurance policies that cover trivial expenses. In terms of health
insurance, you are extremely limited in what you can purchase. You can’t choose
to buy a no-frills catastrophic-expense-only policy. You choice of deductible
options is limited, and your choice of coverage options is probably completely
inflexible. You can’t buy a policy that excludes routine stuff like birth
control or office visits. So with health insurance there is probably no way to
actually follow my “self-insure” advice until there are significant reforms in
health insurance regulation. Finally, perhaps you think that you are especially
skilled at extracting money from your insurance policies. *Other* people buy
the protection plan and just forget about it, but*I’m* going to use it. Or:
This insurance product is overpriced for the *average* customer, but it’s an
especially good deal for me. More power to you, but I suspect that in the long
run you will fail. Insurance companies are pretty good at setting the price to
the risk. So unless you have some very specific knowledge that your insurer
doesn’t have, you’re going to lose this fight.

Quite generally I wish people would get more comfortable
with the concept paying their bills out-of-pocket. A little price-consciousness
would almost surely bring down the very high cost of medicine in the western
world; that price-consciousness is totally absent when someone else is footing
the bill. People want unlimited medical care, paid for by someone else, and
they want the total cost to be affordable to society as a whole. At most maybe
two of these conditions can be met (as Arnold Kling points out in his book on
the economics of medicine, Crisis of Abundance.) If people get more
comfortable with paying their own routine (even some of their
unexpected-but-not-too-severe) medical expenses, we can move into a space where
people manage these trade-offs for themselves. “Self-insure whenever possible”
is good private advice; you don’t have to swallow anything I say about public
policy to follow it, nor do you have to wait for a major policy change to
benefit from it. But I do believe it would lead to some public benefits if we
all got better at managing our own expenses.